NASD Rethinking Scope of Sales Contests Policy - March, 2005

DOW JONES NEWSWIRES
March 16, 2005
By Angela Pruitt

NEW YORK -- As annuity sales come under greater regulatory scrutiny, the National Association of Securities Dealers is taking a second look at its policy on sales contests, a commonly used tactic in promoting the insurance product.

Under current NASD regulations, non-cash sales contests are permitted if they are based on total production of all securities, or all of one type of security. However, broker-dealers may not promote one company's brand over another within a product type.

"We're looking at the scope of our contest rules," said Elisse Walter, executive vice president for regulatory policy at the NASD. Walter said the agency is trying to determine whether or not its policy goes far enough. It's "one of the things on the table today," she said.

As long as contests are conducted within NASD guidelines, broker-dealers don't have to disclose to their clients that they're participating in a sales contest based on generating the most annuity sales.

Annuities, hybrid investment products with a life-insurance wrapper, are at the center of mounting litigation as more senior citizens purchase these vehicles for the guaranteed stream of income they provide. Consumer advocates argue that handsome financial and non-cash rewards - such as sales contests - encourage brokers to push certain annuities on senior citizens that aren't suitable for their retirement needs.

"It's my position that it creates a conflict of interest," said Ron Marron, a California lawyer who is spearheading several lawsuits against some of the largest U.S. brokerage firms and insurance companies for selling bogus annuities to seniors.

He said the lack of full disclosure has become the impetus for steering sales. "I believe under current law it might be legal, but it's certainly not ethical," Marron said of sales contests, which can be quite lavish.

For instance, Merrill Lynch & Co. (MER) sponsored a so-called "Fire and Ice" contest in some of its Texas offices where their financial advisors won a trip to Lake Tahoe and a stay at the Hyatt Regency Hotel in February 2004 for generating the most variable annuity sales. In addition, the advisors won additional points for opening IRA accounts worth $100,000. The costs were defrayed by some major insurance companies, including MetLife Inc.

At the time of the 2004 contest, disclosure to Merrill clients came in the form of a prospectus, which indicated that brokers received non-cash compensation. Merrill now also supplements its disclosure procedure with an additional letter from the investment bank discussing compensation, a Merrill Lynch spokesman said.

Merrill Lynch, Morgan Stanley (MWD), Linsco/Private Ledger Corp. (LPL.XX) and A.G. Edwards & Sons (AGE) all face federal class-action lawsuits alleging improper sales of variable annuities. However, Merrill Lynch's case could be dismissed by a California federal court as requested by the plaintiffs' attorneys, a lawyer for a plaintiff involved with the litigation told Dow Jones Newswires.

Meanwhile, regulators in Massachusetts, New York and California are also taking aim at institutions for what they claim are unscrupulous sales practices.

The NASD policy on annuities generally focuses on suitability issues and the agency currently has a proposal before the Securities and Exchange Commission that would boost suitability requirements for variable annuity sales.

"Suitability is certainly one very important component," Walter said. "Regardless what the form of compensation is, the suitability analysis has to be there."

Tracy Stoneman, a lawyer who represents investors in Colorado, said suitability and full disclosure "are really two different things. In some ways they are mutually exclusive."

She said that something could be unsuitable in part because of what the investor hasn't disclosed and, as such, can contribute to unsuitable sales.

NASD's Walter noted a proposal is being considered that would mandate that registered representatives, including financial advisors, provide some type of disclosure if they are being given financial incentives to promote one investment vehicle over another.

In terms of NASD procedures, including different kinds of products, like variable annuities and mutual funds, is much more complicated. "There is a bit of an apples-and-oranges comparison...because compensation systems can be completely different for each product," Walter said.

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